The galleries, shops, restaurants and professional offices that fill the retail and service needs in and around Santa Fe are often called mom-and-pop businesses.
But for tax purposes, the vast majority of locally owned businesses in New Mexico are “pass-through” entities, such as partnerships, limited liability companies and sole proprietorships. And the Republican tax bill moving forward in the U.S. Congress is bringing new attention to the way small businesses are organized and taxed.
For years, the federal corporate tax rate has been higher than the rates for individuals. So in most cases, those owning a business could pay less overall tax by “passing through” profits to owners or shareholders as income before the end of the year — often in December — at the lower individual tax rates.
The tax bill, as now written, would lower the top corporate rate from the current 35 percent to 21 percent. That change in itself would not have affected many firms in New Mexico because the state has few large corporations that earn enough profit to be subject to the highest corporate rate.
But the latest version of the tax bill, released Friday, benefits pass-through businesses by allowing the owners to deduct some of the money they pay themselves — or not count it toward taxable income.
If those provisions survive House and Senate votes and are signed into law, it would have a lot of impact in New Mexico, said Frank Herdman, a business law specialist with Katz Herdman MacGillivray & Fullerton in Santa Fe.
“The vast majority of businesses in New Mexico are pass-through entities,” Herdman said. “They are owner-operated galleries, restaurants, small retail shops; they are the bread and butter of Santa Fe, if not New Mexico.”
The Republican bill would allow individuals to deduct 20 percent of pass-through income. For married filers, this deduction would begin to phase out after income reaches $315,000.
Herdman also believes the change might keep many business owners from passing through their profits, instead choosing to pay tax at the corporate rate, now proposed to be 21 percent, even though there is a lot more paperwork to file taxes as a corporation.
“I think it has the potential to have a beneficial effect if they are able to take advantage of that lower corporate tax rate,” he said. “It could be very beneficial for small businesses.”
Kevin M. Brennan, a tax accountant in Santa Fe, said everyone who follows tax law has been watching the language in the proposed tax bill to see what it means. He is unsure of the impact at this point because lower individual rates might mean that it still makes sense for businesses owners without a lot of revenue to “pass through” profits, depending on their circumstances.
“The pass-through part of the legislation is the most complicated,” he said, “and everyone’s trying to get a grasp of it.” Regardless, he said, the changes would give business owners more options.
The legislation also cuts the top individual rate to 37 percent from 39.6 percent and doubles the standard deduction. The law would scale back who can take deductions for mortgage interest, as well as deductions for state and local taxes.
Another last-minute change unveiled Friday would have a big impact on New Mexican families who have children. The final bill doubles the child tax credit to $2,000 and allows families who pay no federal income tax to receive a refundable credit or cash back of $1,400 per child.
The child tax credit currently is available for filers who have children under age 17 and incomes up to $115,000. The final bill expands the credit to families earning up to $500,000, an amount that would take in two-earner couples in Los Alamos as well as most members of Congress.
Almost 17 percent of all filers in New Mexico claim the child tax, versus 13 percent nationwide.
The Republican members of the House-Senate conference committee that reconciled differences between the bills passed by each chamber released their report Friday with plans to bring the bill for a final vote early next week.
The legislation would add more than $1 trillion to the federal deficit, and with most of the tax relief going to businesses and with breaks included for high-income taxpayers, Democrats have largely opposed the bill.
Opponents argue that the spiking deficit will force future reductions in Social Security, Medicare and Medicaid.
“This Republican tax plan gives the biggest corporations and the wealthiest Americans a massive, permanent tax break,” U.S. Sen. Tom Udall, D-N.M., said in a statement Friday. “Meanwhile, it would saddle the rest of the country with a $1.5 trillion deficit hole, which would mean a huge tax increase on most Americans down the road — in the form of $12,500 in debt per family and cuts to Social Security, Medicare, and Medicaid.”
Udall said the bill would also chip away at the health insurance mandate under the Affordable Care Act.
“This bill’s attack on the Affordable Care Act will leave 13 million Americans without health care, and send premiums and out-of-pocket costs soaring across the country,” he said. “This tax bill would be especially disastrous for New Mexico, sending us on a collision course for a huge budget cut.”
Contact Bruce Krasnow at email@example.com.